5.1 Having decided that there is a need to reintroduce the law established by the Statutes of Set-off, the Commission then considered whether there are any aspects of this law which require reform.
NARROW COVERAGE
5.2 The proliferation and separate development of the many different types of set-off has not prevented situations arising where a form of set-off is not available but where justice might expect it to be. This situation, particularly with regard to the availability of equitable set-off and set-off under the Statutes of Set-off, has recently been considered absurd by some Judges of the English Court of Appeal.1 For example, Lord Justice Leggatt observed:
I would add ... the comment that the state of the law is unsatisfactory that allows a set-off at law of debts which are liquidated, even if unconnected, and in equity of debts which are connected, even if unliquidated, but not a set-off of debts which are both unliquidated and unconnected.2
5.3 This view has, however, been criticised by at least one commentator who suggests that the law is not wrong to refuse set-off where debts are both unliquidated and unconnected because there is no merit in making such a right available and in particular such a change in the law would:
- create delay, especially with respect to summary judgments;
- encourage the raising of spurious defences; and
- couple together unrelated claims.3
5.4 Lord Justice Staughton’s more limited criticism of the current arrangements concerning set-off, made in the same judgment, has been better received. He stated that the historical development of set-off:
has led to results which appear to lack logic and sense. Legal set-off is available if both claims are for liquidated sums. Thus if a plaintiff has a claim for unliquidated damages, the defendant cannot at law seek to set-off a liquidated claim.
I can see no sense in that today. This rule was mitigated by the Court of Chancery through the doctrine of equitable set-off which is available in broad terms if there is a sufficient degree of connection between the two transactions, whether or not either or both claims are unliquidated. But, as Leggatt LJ has pointed out, it is questionable whether the remedy is wholly effective as a cure for the disease.4
The two main issues arising are dealt with in the following paragraphs.
Requirement that both claims be due and payable
5.5 Traditionally, set-off under the Statutes of Set-off has been held to be available where both debts are due and payable when the plaintiff commences his or her action at law.5 This means that where a debtor’s liquidated cross-claim becomes due and payable only after the commencement of the creditor’s proceedings, the cross claim cannot be set-off against the original claim. This position should be considered in light of the fact that rules of court now allow a party to plead any matter which has arisen since the commencement of the action:
A party may plead any matter notwithstanding that the matter has arisen after the commencement of the proceedings.6
Wood has also suggested that the traditional position is difficult to reconcile with current practice.7
5.6 There have been judicial statements, including from the House of Lords, that call into question the traditional position and some decisions have allowed set-off of debts assigned to a defendant after the commencement of the plaintiff’s action.8 For example, Lord Hoffman has stated that set-off under the Statutes of Set-off is confined to debts “which at the time when the defence of set-off is filed were due and payable”.9
5.7 The practical problem caused by the traditional position can be seen by considering a situation where there has been an assignment of a creditor’s claim and the assignee then seeks enforcement of the claim. The debtor may have a cross claim against the original creditor, but to qualify for set-off the debtor’s cross claim must have become due and payable before the commencement of the assignee’s action. Set-off can, therefore, be precluded simply by the assignee taking action before the debtor’s cross claim becomes due and payable.10
5.8 There appears to be no compelling reason why the statement of Lord Hoffman should not represent the law instead of the traditional position.11 Since the law is progressing this way, two options present themselves: first, recommending no mention of when debts become due and payable and leaving the issue to the courts; and secondly, including a provision along the lines of Lord Hoffman’s statement.
5.9 The Commission accordingly prefers to avoid any doubt which may exist in this regard by recommending a provision to the effect that set-off be available where the debts are due and payable at the time when the defence of set-off is filed. Care will need to be taken in drafting the new provision to ensure that the operation of s 74 of the Limitation Act 1969 (NSW)12 is not adversely affected.
Requirement that claims be liquidated
5.10 Set-off under the Statutes of Set-off differs from equitable and insolvency set-off in not allowing unliquidated claims to be pursued. It has been questioned whether the requirement that claims be liquidated or readily ascertainable is justified. The requirement is seen as arising from an unwillingness on the part of the courts to deal with two different claims in the one action so as to avoid delay. This is particularly so where a creditor’s claim is clear and undisputed.
5.11 One result is that, where a claim is unliquidated, the defendant will need to raise a counterclaim and, if the claim is unrelated, he or she may be forced to institute separate proceedings. This means that a defendant may be subject to the whole of the judgment in the first proceedings before the defendant’s own claim against the plaintiff has been adjudicated.
5.12 On balance and, in particular, because of the delays that may be brought into otherwise clear cut cases of liquidated demands, the Commission has decided not to extend the availability of statutory set-off to cases involving unliquidated demands.
EFFECT ON SECURITISATION ARRANGEMENTS
5.13 One submission has pointed out that set-off, in particular statutory set-off, may be a cause of concern with respect to the practice of securitisation.13 Securitisation refers to the selling of marketable securities backed by expected income streams from specific assets. The assets may be debts (mortgages in particular, but also credit card receivables, motor vehicle loans and other forms of consumer credit) or equity (for example, shares). Usually the securities are pooled together for more efficient operation. The most common form in Australia are called “mortgage backed securities” while those backed by assets other than mortgages are called “asset backed securities”. A “special purpose vehicle” (often a trustee) is created by the “originator”. The special purpose vehicle receives repayments and ensures that the holders of the securities (the investors) are paid the appropriate return. It also ensures that managers are paid the appropriate commission. Credit rating agencies assess and assign ratings to proposed securitisation arrangements.14 The securitisation market in Australia was valued at $12.4 billion in June 1996.15
5.14 It has been the practice of ratings agencies involved in the securitisation market to require that the relevant agreements exclude set-off. The submission to the Commission has urged the necessity of making clear that statutory set-off can be negated by contract since uncertainty in this area will be to the disadvantage of banks and financial institutions engaging in securitisation. It has been argued that there are considerable cost savings arising from securitisation and that if banks and financial institutions are prevented by statutory set-off from taking part, “it is reasonable to expect that their charges and/or interest costs will increase”.16
5.15 The law is uncertain in this regard.17 Traditionally it has been held that an agreement to exclude set-off under the Statutes of Set-off cannot be enforced.18 However, there have been decisions to the contrary.19 Derham has noted that in guarantee situations, debtors and creditors can contract to exclude set-off with respect to a guaranteed debt and that the guarantor cannot claim (barring insolvency proceedings) what the debtor could never have in the first place.20
5.16 Statutory recognition of agreements excluding set-off appears to be desirable, especially given the fact that complex commercial arrangements may be involved. Therefore, to remove any doubt in this regard the Commission recommends that it be possible to exclude set-off under the Statutes of Set-off by agreement between the parties.
OPERATION OF THE NEW ENACTMENT
5.17 Some difficulty exists regarding the commencement of the new provisions. This arises from the fact that set-off has technically not been available in New South Wales for the past 30 years.
5.18 A number of points need to be considered. The first is that, at least prima facie, there is an assumption that agreements entered into over the 30 years since the repeal of the Statutes of Set-off have been finalised on the understanding that set-off was not available. There would, therefore, have been no need to agree to exclude set-off under the Statutes of Set-off.21 On the other hand, the legal position has been far from clear. It is reasonable to assume that many thought that set-off established by the Statutes of Set-off did continue to exist since it had been an established and important common law doctrine over the previous two centuries and was still in force in many other common law jurisdictions.22
5.19 A further point to be considered is that the reintroduction of set-off under the Statutes of Set-off is clearly premised upon its general desirability. Indeed two submissions recognised this to the extent that they were prepared to advocate that the new provision apply to debts arising before its commencement,23 with one of these prepared to do so notwithstanding an otherwise general opposition to the concept of retrospectivity in legislation.24
5.20 The Commission has considered a number of options for protecting agreements entered into on the understanding that statutory set-off was not available, while extending set-off to situations where it would otherwise be desirable and possibly assumed in any case. These options included defining the types of agreements which would have been entered into on the understanding that set-off was not available and setting up a rebuttable presumption.
5.21 In the end, the Commission has decided that, on balance, the transitional provision which best achieves a fair and just outcome in the cases mentioned in paragraph 5.18 is one which allows a general application of the new provision by stating that, subject to any agreement to the contrary, it applies to any debt whether arising before or after the commencement of the new provision. However, the Commission has also decided to give the courts a discretion to disallow set-off in relation to agreements entered into before the commencement of the new provision where it is in the interests of justice to do so. We make this recommendation in the expectation that the courts will exercise their discretion in situations where it is clear that set-off under the Statutes of Set-off was not expressly excluded because it was assumed that the law no longer applied. We particularly have in mind securitisation and other similar transactions.
5.22 The exercise of the discretion to disallow set-off will be available only with respect to set-off arising under an agreement entered into before the commencement of the new provisions. The provision granting the discretion will, therefore, be transitional in nature as the number of agreements will be finite and the agreements themselves will eventually cease to have effect.
Recommendation 5
That, subject to any agreement to the contrary, the new provision apply to any debt whether arising before or after its commencement. However, the courts shall have a discretion to disallow set-off in relation to a debt arising under an agreement entered into before the commencement of the provision, if it is satisfied that it would be in the interests of justice to make such an order.
FOOTNOTES
1. Axel Johnson Petroleum AB v M G Mineral Group AG [1992] 1 WLR 270.
2. Axel Johnson Petroleum AB v M G Mineral Group AG [1992] 1 WLR 270 at 274 (Leggatt LJ).
3. N H Andrews, “The Proper Limits of Set-off” (1992) 51 Cambridge Law Journal 239 at 240. See also S R Derham, “Set-off in Victoria” (1999) 73 Australian Law Journal 754 at 756-759.
4. Axel Johnson Petroleum AB v M G Mineral Group AG [1992] 1 WLR 270 at 275-276 (Staughton LJ).
5. See para 2.10 above.
6. Supreme Court Rules 1970 (NSW) Pt 15 r 16. See S R Derham and Victorian Bar Council, Submission at 4.
7. P R Wood, English and International Set-off (Sweet & Maxwell, London, 1989) at para 6-30 - 6-31. See also DP 40 at para 2.15-2.16.
8. See Wood v Goodwin [1884] WN 17; and Ingleton v Coates (1896) 2 ALR 154. See also McColl’s Wholesale Pty Ltd v State Bank of NSW [1984] 3 NSWLR 365 at 381 (Powell J).
9. Stein v Blake [1996] AC 243 at 251.
10. P R Wood, English and International Set-off (Sweet & Maxwell, London, 1989) at para 6-30 - 6-31. For the position where equitable set-off is available see Roadshow Entertainment Pty Ltd v (ACN 053 006 269) Pty Ltd (1997) 42 NSWLR 462 at 481-482.
11. See S R Derham and Victorian Bar Council, Submission at 5.
12. See para 3.11.
13. M Wormell, Submission.
14. See Australia, Financial System Inquiry Final Report (AGPS, 1997) at 161-165; Organisation for Economic Co-operation and Development, “Finance, Investment, Taxation and Competition: Securitisation” (as at 9 February 1999) <www.oecd.org/daf/ fin/netsecu.htm>.
15. Australia, Financial System Inquiry Final Report (AGPS, 1997) at 165.
16. M Wormell, Submission at 4.
17. See R P Meagher, W M C Gummow and J R F Lehane, Equity: Doctrines and Remedies (3rd edition, Butterworths, Sydney, 1992) at para 3704.
18. Lechmere v Hawkins (1798) 2 Esp 625; 170 ER 477 (on the grounds that equity would grant relief anyway); and M’Gillivray v Simson (1826) 2 C&P 320; 172 ER 145.
19. Re Agra & Masterman’s Bank (1867) LR 2 Ch 391 at 397 (Cairns LJ); Re Northern Assam Tea Co (1870) LR 10 Eq 458 at 464 (Lord Romilly MR); Phoenix Assurance Co Ltd v Earls Court Ltd (1913) 30 TLR 50.
20. S R Derham, Set-off (2nd edition, Clarendon Press, Oxford, 1996) at 652.
21. M Wormell, Submission at 3.
22. Not least of which are Victoria and England.
23. Law Society of NSW, Submission 2; and K R Handley, Submission at para 10.
24. Law Society of NSW, Submission 2.
